Description

The original formatted idea is attached here.

Summary

The Buckle, Inc. (“Buckle”, “the Company”, or “BKE”) (see Exhibit 1) is a fast fashion retailer of medium to better–priced casual apparel, footwear and accessories for 15 to 30-year-old men and women.  Buckle markets a wide selection of brand names and private-label casual apparel. Denim is a significant contributor to total sales (39.6% of fiscal 2021 net sales) and is a key to the Company's merchandising strategy. At the end of the 2021 fiscal year, the Company operated 440 retail stores (predominately in shopping malls) in 42 states. The Company headquarters and distribution center are in Kearney, Nebraska.  It was founded in 1948 by the current Chairman’s father.  BKE went public in 1992.

The Company emphasizes personalized attention to its guests (customers) and provides individual customer services such as free alterations, layaway services, free gift packaging, personalized stylist services, a guest loyalty program, and the Buckle private label credit card.  A majority of the Company’s store managers, district managers, and executive management team are life Buckle salespeople, including President and CEO, Dennis Nelson, and Chairman, Daniel Hirschfeld.  Messrs. Nelson (72), Hirschfeld (80), and key insiders collectively own over 40% of the outstanding shares.  Over the last 15 years, Mr. Hirschfeld has sold >25% of his shares but still controls 33%.  Although the board pays and promotes talent from within, there is an unclear succession plan that raises questions on BKE’s ongoing ability to operate in such a shareholder-friendly manner exacerbated by the fact that no other named executive owns greater than 0.5% (>50 bps) of the Company’s shares (see Exhibit 2).  At this point in the Company’s life cycle, it is critical that the board ensures knowledge transfer to younger executives.  Unfortunately, without proper share ownership incentives, cultural disruption might be imminent, and the board might be forced to recruit its next CEO/COO talent externally.  One of the Company’s strongest investment themes has been its rare mix of owner/managers who understand shareholder value.

BKE has averaged EBIT margins of 15.9%, 18.1%, and 19.4% for the most recent ~30-year, 20-year, and 10-year periods.  Over the last 10 years, margins have been around 20%.  The latest LTM EBIT margins are >25.0% (see Exhibit 13), which is an all-time high in the Company’s operating history.  We note that EBIT margins have been volatile for the last 10 years, rising to 23% in fiscal 2014, then sequentially falling to a low of 13% in fiscal 2019, then rising vigorously again to 25% in the 2Q of fiscal 2022.  During this period, the Company kept employee store compensation levels steady as it increased its online fulfillment efforts, targeted store/online advertising campaigns, increased unit prices, and negotiated better vendor pricing.  This is carefully seen within gross margins (excl. store occupancy costs) trends over the same 10-year period, as gross product margins remained consistent at 50%, but then rose sharply to 59% in the last four years (see Exhibit 25, line 18).  

With a total enterprise value of $1.62 billion, we estimate that the market is pricing BKE at a 5.0x EBITDA multiple and ~14% EBIT margins (see Exhibit 1 and Exhibit 42).  Historically, the Company has traded at 8.0x EV/EBIT vs Luxury and Big Box Retailers that historically trade at 14.2x and 10.7x EV/EBIT multiples (see Exhibit 38 and Exhibit 40).  This discount to peer multiples is a result of the Company’s anemic 5-10% sales and earnings growth over the last 30 years.  Rather than expand through acquisitions or debt issuance (vs peers), the Company has instead targeted 20% unlevered equity returns and redistributed cash back to investors.  “Profitability over growth” seems to be the theme since the 1980s.  In extremely competitive apparel it is best to pick spots and focus on profitability.  The best retail comparison might be See’s Candy Shops, Inc. (“See’s”), owned by Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A).  See’s produces boxed chocolates and other confectionery products with an emphasis on quality and distinctiveness in two large kitchens in Los Angeles and South San Francisco and a facility in Burlingame, California.  See’s operates ~250 retail stores located in California and Western states, as well as over 125 seasonal locations.  At the 2019 Berkshire annual shareholder meeting, Buffett said about See’s, “we put $25 million into it and it's given us over $2 billion of pretax income, well over $2 billion."  The goal for See’s has not been to be the biggest or to cater to everyone but to grow its niche and limit any capital investments that would cannibalize or distract from its core high-ROIC business.  BKE seems to have a similar goal.  Since 1999, BKE has returned $2.6 billion to investors in the form of dividends and share buybacks.  

From a total return, BKE outperformed the S&P 500 significantly (see Exhibit 48 and Exhibit 49).  Therefore, as a result, we recommend purchasing the stock at or below $25 per share, which gets closer to BKE’s historical low EBIT multiples of 3.5x (see Exhibit 42).  We believe BKE’s fundamental characteristics at our recommendation follow our preference of buying: (i) companies with demonstrated consistent earning power; (ii) businesses earning good returns on equity while employing little or no debt; (iii) exceptional management in place ; (iv) simple businesses; and (v) a fair price.  BKE appears to fit on all accounts.

Company History 

Buckle began as a men's clothing store in 1948 in Kearney, Nebraska (pronounced Car-nee), and now has stores across in 42 states (Exhibit 3). The first store was founded by David Hirschfeld and operated under the name "Mills Clothing".  His son Dan took over the operations in 1965.  In 1967 a second store was purchased and operated under the name "Brass Buckle".  At that point, the Company began selling more casual men's clothing and by the early 1970's Brass Buckle had developed into a denim-based store.  In 1977 the Company introduced women's apparel and has since evolved into its current incarnation. Brass Buckle changed its name in 1991 to The Buckle, and in 1992, the Company went public on the NASDAQ and traded as BKLE at $2.00/share (split-adjusted).  In 1997, The Buckle moved to the New York Stock Exchange where it now trades under the symbol BKE.

Throughout the years many changes have occurred in fashion, retail, and within the Company.  However, BKE management believes one constant has driven Buckle's success: its mission "to create the most enjoyable shopping experience possible for our guests."  The Buckle management team has a long history with the company.  As mentioned, Dan Hirschfeld has been with the company since 1965 and leads the company as Chairman of the Board.  Dennis Nelson is the President and Chief Executive Officer and has been with the company for over 30 years.  Mr. Nelson began as a part-time salesman while he was a college student and continued full-time after graduation.  He has helped lead the company to over 440 stores and is actively involved in all phases of the company's operations.  Kari Smith, Vice-President of Sales, has been with the company for 25 years.  Individuals and Insiders currently own 43% of the company.  

Competitive Strengths and Company Overview

The Buckle, Inc. is a retailer of medium to better–priced casual apparel, footwear, and accessories for 15 to 30-year-old men and women.  The majority of the Company's central office functions, including purchasing, pricing, accounting, advertising, and distribution, are controlled from its headquarters and distribution center in Kearney, Nebraska.  As of January 29, 2022, the Company had approximately 8,300 employees (called teammates) - approximately 2,800 of whom were full-time.  Buckle operates like a family-run business, and the majority of the management team, from store managers to senior management, began their career at Buckle on the sales floor.  This gives the Company a unique perspective on the business as well as a sense of loyalty and culture that is missing at many of its direct competitors. 

The Company emphasizes personalized attention to its guests (customers) and provides individual customer services such as free alterations, free gift wrapping, layaways, a frequent shopper program (the Buckle Primo Card), and the Buckle private label credit card.  The Company has an Executive Vice President of Stores, a Senior Vice President of Sales, 3 Vice Presidents of Sales, 4 Regional Managers, 22 District Managers, and 76 Area Managers. Certain district managers and all area managers also serve as manager of their home base store. In general, each store has 1 manager, 1 or 2 assistant managers, 1 to 3 additional full-time salespeople, and up to 20 part-time salespeople. Most stores have peak levels of staff during the back-to-school and holiday seasons. Almost every location also employs an alterations person.

Buckle markets a wide selection of brand names and private label casual apparel. Denim is a significant contributor to total sales (39.6 % of fiscal 2021 net sales, see Exhibit 4) and is a key to the Company's merchandising strategy. The Company believes it attracts customers with its wide selection of branded and private label denim and a wide variety of fits, finishes, and styles. Tops are also significant contributors to total sales (30.2 % of fiscal 2021 net sales). The Company strives to provide a continually changing selection of the latest casual fast fashions.  Brand name merchandise accounted for approximately 57% of the Company's sales during fiscal 2021. The remaining balance is comprised of private label merchandise.   The Company currently offers denim from brands such as Miss Me, Rock Revival, KanCan, Bridge by GLY, Flying Monkey, Levi's, Preme, Smoke Rise, Vervet, and Wrangler.  Other key brands include Hurley, Billabong, Affliction, American Fighter, Sullen, Howitzer, Oakley, Fox, RVCA, Ariat, 7 Diamonds, Nixon, Free People, Z Supply, Salt Life, White Crow, Brew City, Modish Rebel, HYFVE, Versace, American Highway, Eight X, Kimes Ranch, SOREL, Hey Dude, Steve Madden, Dolce Vita, SAXX, Stance, Pura Vida, Ray-Ban, Wanakome, Guess, Fossil, Brixton, Dr. Marten, Very G, Birkenstock, Bed Stu, and G-Shock.

The Company has an experienced buying team, which contributes significantly to the Company’s success by enabling it to react quickly to changes in fashion and by providing extensive knowledge of sources for both branded and private label goods.  The Company purchases products from manufacturers within the United States as well as from agents who source goods from foreign manufacturers.  Buckle has not experienced any material difficulties with merchandise manufactured in foreign countries.  The Company does not have long-term or exclusive contracts with any brand name manufacturer, private label manufacturer, or supplier.  In fiscal 2021, Axis Denim (which produces private label denim for the Company) accounted for 15.6% of net sales (see Exhibit 10).  No other vendor accounted for more than 10% of the Company’s net sales.

Expansion Strategy

Buckle has grown its store base consistently at approximately a 6% CAGR since 1992, and 2% over the last 10 years (Exhibit 5).   The Company's criteria when considering a particular location for expansion include: 

1. Market area, including proximity to existing markets to capitalize on name recognition;

2. Trade area population (number, average age, and college population);

3. Economic vitality of market area;

4. Mall location, anchor tenants, tenant mix, and average sales per square foot;

5. Available location within a mall, square footage, storefront width, and facility of using the current store design;

6. Availability of experienced management personnel for the market;

7. Cost of rent, including minimum rent, common area, and extra charges;

8. Estimated construction costs, including landlord charge backs and tenant allowances.

As of August 2022, the Company operated 440 retail stores in 42 states (~85% of stores are in shopping malls).  The average store is approximately 5,000 square feet (of which the Company estimates an average of ~80% is selling space), and stores range in size from 2,900 square feet to 8,475 square feet.  The Company generally seeks sites of 4,250 to 5,000 square feet for its stores.  

With 17-18% of its store fleet in smaller markets, with communities of 50,000 or less, BKE enjoys industry-leading rent (which some analysts estimate to be ~$28 per square foot and at ~9.1% of sales), but store productivity in terms of sales per sqft (“SSF”) of $468 (Exhibit 8) and revenue per store of $2.43 million (Exhibit 9) have remained below industry medians, particularly revenue per store (Exhibit 23), highlighting the fierce competitiveness of fast fashion youth apparel.  

The Company completed an 82,200 square foot expansion to its corporate headquarters facility during fiscal 2005, which housed its online fulfillment and customer service center as well as its supplies and returns-to-vendor departments.  During fiscal 2010, the Company completed the construction of a $25 million, 240,000-square-foot distribution center in Kearney, Nebraska (Exhibit 7).  The Company transitioned to the new distribution center in September 2010 and the new facility is currently the Company’s only operating store distribution center.  The Company also owns two additional facilities as part of its home office campus in Kearney, Nebraska (one of which was completed during the first quarter of fiscal 2015). 

BKE does not have multiple layers of management and the merchants are empowered to make decisions.  A merchants’ ability to quickly shift purchasing dollars into emerging brands and/or categories has helped bolster BKE’s success.  

Positives

Strong, Experienced Management

The Buckle’s executive team has a conservative management style that should allow for less volatile performance.  The team is careful with how it opens new stores, makes decisions about its assortment and manages its balance sheet.  The company has no debt and favors special dividends to buybacks.  Many of the top executives in the company have been with the Buckle for the majority or all of their careers.  This leads them to think of themselves as “stewards” of the company to a greater degree, potentially, than executives at many other retailers.

The Company places great importance on educating quality personnel. In addition to sharing career opportunities with current Buckle employees, the Company also recruits interns and management trainees from college campuses. A majority of the Company’s store managers, all of its area and district managers, and most of its executive management team are former salespeople, including President and CEO, Dennis Nelson, and Chairman, Daniel Hirschfeld. Recognizing talent and promoting managers from within allows the Company to build a solid foundation for management. The buying team is led by the Vice President of Women’s Merchandising and Vice President of Men’s Merchandising, who have over 63 years of combined experience with the Company.  Management believes the experience and leadership within the buying team contribute significantly to the Company’s success by enabling the buying team to react quickly to changes in fast fashion and by providing extensive knowledge of sources for both branded and private label goods.

Capitalizing on Brand Trends

Buckle’s success, however, is in part due to its ability effectively brand assort.  Branded products represent 57% of 2021 fiscal year sales.  In the mid-2000s, merchants at Buckle successfully began adding new brands to the collection, which resulted in an updated look and style for the Company.  The core customer has responded favorably to the evolution beyond surf brands.  Not only has Buckle effectively identified emerging brands ahead of many competitors, but the Company has also partnered with many of these brands to develop exclusive products for its stores.  We believe this has solidified Buckle’s relationship with brand-loyal shoppers and enabled the Company to offer a unique assortment.  The Company’s brand mix changes regularly now to support current trends in the market.  The Company continually strives to offer brands that are currently popular with its customers and, therefore, the Company's suppliers and purchases from specific vendors may vary significantly from year to year.  As a result, Buckle’s long-term outlook is not necessarily tied to current fast fashion trends, or that recent success was simply a result of favorable fashion trends.  Instead, Buckle has proven it can adapt its merchandising strategy to embrace emerging brands and the latest trends. 

Buckle has broken out its top performing brands in each year’s annual report, noting any individual brands representing over 10% of total sales for the Company.  These brands are listed each year in order of total sales from greatest to least.  Exhibit 10, illustrates BKE’s ability to rotate seamlessly from brand to brand depending on what is most popular with the core customer or “guests”.  For example, following the lifecycles of Fossil and Miss Me from their first introductions (1999 for Fossil and 2008 for Miss Me) to the rise of each brand as a percent of sales to their peak (2002/2003 for Fossil and 2014 for Miss Me) followed by their decline in subsequent years, demonstrates BKE’s capabilities.  Similarly, Lucky Brand Dungarees dominated the top vendor spot for over a decade from 1992-2007.  Finally, note the continued proliferation of the top brand list over the past five years showing BKE’s continued brand diversification.  

Buckle’s merchandising strategy is different than other core youth retailers because Buckle sells branded product along with its private label.  Buckle’s private label is designed to complement its branded offering but not intended to be a logo-driven business.  In addition, the Company’s private label products generally earn a higher margin than branded products and have grown over the past 20 years (see Exhibit 11).  Thus, reductions in the private label mix would decrease the Company’s merchandise margins.  We think this strategy has benefited the Company significantly over the past few years for a few key reasons (i) Buckle’s assortment is easy to mix and match to create unique looks, which we think has helped the retailer compete with the new fast fashion players (e.g. H&M, Forever21, Rue, etc.) as well as steal market share from some of its less differentiated and more logo-driven peers.  We believe the takeaway is that young people, particularly women, do not want to dress in head-to-toe logo wear.  (ii) The “Buckle” brand name is not readily apparent in Buckle’s private label merchandise, thus allowing for broader market appeal.  The BKE brand today reaches a wider age demographic than it did even four or five years ago. While a 30-year-old customer might feel inappropriate wearing a top from Aeropostale, American Eagle, or Abercrombie & Fitch, we think some older shoppers find Buckle’s products attractive and don’t feel too old wearing them.  These competitor retailers specifically target casual wear for consumers aged 22 or younger.  (iii) The private label offers many of the same trend and style elements featured in the branded product but at lower price points.  This value proposition has helped and should continue to help the Company in tough economic environments, demonstrated by gross margins remaining within 40%-50%, despite various recessionary periods (see Exhibit 11). 

We believe the increase in private label as a percentage of total sales over the last 10 years has been quite beneficial to margins and should continue to help cushion margins against increases in labor and commodity prices.  

In addition, as private label penetration has increased so has average unit pricing (see Exhibit 12).  We believe this is due to Buckle’s unique in-store customer selling strategy which can guide guest purchasing.  The Company relies on its people, not expensive marketing or promotions to sell its product and disseminate its brand message.  The Company’s marketing expenses are lower than most, ~1% of sales vs. mean of 2.1% for a group of similar retailers (Abercrombie, American Eagle, Aéropostale, Ann Taylor, Chico’s, Claire's, Gap Inc., rue21 and Urban Outfitters) due to its focused customer service.  

We believe that sales staff is trained to know apparel product better than the competition, which builds credibility and creates a unique shopping environment.  The salespeople at Buckle take the time to get know the customers, which help them better recommend styles of denim or the right top to go with a specific bottom.  The fact that most senior employees started as salespeople lay the foundation for Buckle’s culture, which, in a volatile environment, can help stabilize BKE’s ability to capture guest purchases.  In addition to the Company’s successful loyalty program (the Primo card), BKE offers its customers layaway, free alterations, and a private-label credit card that accrues reward points.  

Salespeople are paid hourly plus 3% commission of all attributed sales.  There is clear upward mobility within the Company.  Nearly the entire executive management team started in part-time sales and the majority of BKE’s store, area and district managers were once selling in BKE stores as well.  As a testament to the deep-rooted culture at Buckle, its regional and district managers have an average of 34 years with the Company and around 50% of all store managers have been with BKE for over three years.  BKE invests heavily in the education and development of its managers and store staff by hosting company-wide meetings, small career meetings and by creating educational videos and tools to increase productivity.

We believe that this is BKE’s competitive advantage or “moat”: a culture that not only understands fast fashion, but also can create an environment to suit each guest to maximize guest purchases.

Potential Upside in Continued Store Expansion

Another compelling positive for Buckle is that the Company still has a long runway for store growth, particularly in underpenetrated markets.  Buckle had 442 stores at July 31, 2022.  Buckle has not opened more than 20 new stores per year over since fiscal 2010, and has netted 9 new stores per years since fiscal 2000.  We anticipate this trend remaining the same going forward.  However, in terms of headroom for the concept, we believe the U.S. could ultimately support well over 600 stores, but do not see management indulging in this type of growth.  We do anticipate total domestic store potential in the low 500’s over the next 10 years, but this number might rise toward the high 500’s if Buckle continues to execute solidly on real estate and with its product assortment.  Buckle currently only has stores in the US. Expansion beyond Canada could eventually be possible, but Buckle is conservative with growth plans, so we do not expect any expansion outside of North America for the foreseeable future.  

New stores require approximately $1,000,000: $800,000 in cap-ex with another $200,000 in inventory (net of payables).  We estimate a first-year ROI of around 50% with a two-year payback.  In addition to selective store expansion, BKE has embarked on an aggressive remodeling program since 2009.  The full remodels are comparable to that of a new store in terms of cap-ex and typically generate a 15% to 20% lift in sales.  We believe that a majority of the store base is now in the newest format.  Between 2006 and 2017, BKE digested some of the largest investments made in its history (e.g., DC, online fulfillment, improvements to website, infrastructure, and a large number of new stores and remodels).  The total price for this revamp was ~$435million or 70% of all cap-ex from 2000 through 2021.  We anticipate maintenance cap-ex to be between $10 million to $20 million over the next couple of years.  We believe that this focused store improvement plan was a big reason for BKE’s increased SSS and margins over the last few years (see Exhibit 13).  As a result, we expect SSS to potentially normalize to low single digits over the next few years and revenue per sqft to stay at around $440 (see Exhibit 14).  

Key potential underpenetrated markets include the Northeast (5% of stores) and the West (>16% of stores).  Key competitors (i.e., American Eagle, Express, Banana Republic, Hollister, etc.) all have greater than 500 stores.  Potentially, if Buckle can find good locations in the Northeast (i.e., MA, NY, and NJ) and California, there is a chance that these stores (which would be located in densely populated markets) could achieve higher sales productivity than the chain average.  

Online Expansion

While BKE first launched its online store in April 1999, sales from this important channel have only recently become meaningful enough for management to call out.  BKE has invested heavily in driving sales to its online store over the past few years.  Online sales have grown to $221 million for the 12 months ended April 30, 2022, or 17% of sales.  Buckle can continue to drive sales growth via e-commerce.  Online sales at BKE have increased at a 15% CAGR from 2008 to today (see Exhibit 15).  We believe that BKE’s online sales can contribute >20% to the top line over the next two to three years.  

Interestingly, digital sales vs storefront sales have converged (nka “omni-channel” by the industry) within the industry.  Investments in areas such as marketing campaigns, technology advancements, warehousing, fulfillment, etc., have generated demand for an omni-channel approach to retail operations, resulting in the industry trending to report store and digital channels sales within one revenue figure.  We believe there is decent growth left in this channel for BKE.  For example, before merging its online and store sales channels, Urban Outfitters had ~40% of online sales.  It is unclear how much longer Buckle will report separate digital sales, but it has grown its digital channel from 7.3% in Fiscal 2011 to 17.1% of sales in Fiscal 2021.  

Large Cash Position and Special Dividends

The Company currently has cash equal to ~35% of assets and ~17% of market capitalization.  We believe that this cash position should allow the company to continue to grow or manage profitability.  Buckle has issued special dividends in each of the last 14 years.  We think the Buckle is likely to continue to return cash to shareholders in this method, as the company has historically consistently favored dividends to buybacks.  From 2000 to 2022, the Company used $193 million ($183 million from 2000-2008) for share buybacks, issued $1.5 billion and in $880 million in special and common dividends, totaling $2.6 billion in total distributions to investors over the last 22 years.  That is more than 1.5x the value of BKE current market capitalization.  Assuming further special dividends of a similar size to recent dividends could result in a dividend yield in the mid-single-digit percentage range long-term.

Good Operating Cash Conversion 

The Company has brought down its cash conversion cycle (i.e., the net number of days it collects cash from operations) since pre-crisis (see Exhibit 16).  Part of the reason, we believe, for this is the Company’s ability to source fashionable inventory that can sell quickly.  Another reason for improved cash conversion is that its growing online platform has been used as an inventory clearance tool.  However, what strikes us as the most critical reason for improved cash conversion is that the Company has been able to gain adequate scale to work with its vendors in determining appropriate and proper inventory for the latest fashion.  

BKE has managed to put itself in a select group of national retailers that run efficient cash conversion models below 60 days (see Exhibit 17).  In the most recent LTM period, BKE appears to have improved its cash conversion to below 40 days.  

Gift certificates/cards have also grown 7% CAGR (see Exhibit 18), since 2005, which is another venue for quicker cash conversion in the business.  Breakage (i.e., revenue gained by retailers through unredeemed, expired or lost gift cards) has been materially small, meaning that customer utilization is high.  

Compensation Structure 

Senior management is paid in base salary, cash bonus, and non-vested performance-based stock.  The Bonus Pool is a cash incentive for executives.  It is calculated each year by the Compensation Committee based upon dollars of growth in a key performance Base Year Target Amount (“Target”), then multiplied by (i) the applicable established percentage set by the Compensation Committee in the previous fiscal year and then multiplied again by (ii) a factor determined by the increase above the previous year’s Base Amount Target.  The Base Year Target amount is the previous year’s Pre-Bonus Net Income.  For example, in Fiscal Year 2021 (Jan 2021-Jan 2022):

• For part (i), 1.2% of fiscal 2021's Pre-Bonus Net Income.  

• For part (ii), if fiscal 2021's Pre-Bonus Net Income exceeded the Company's Target Pre-Bonus Net Income Amount, then a percentage of the amount above the Target would be added to the Base Amount in calculating the total Bonus Pool (see Exhibit 19).  

• The Bonus Pool, computed in accordance with the 2021 Management Incentive Plan, resulted in a bonus pool of $16,133,509.

Non-Vested Stock is currently the only long-term performance-based component of the Company’s executive compensation program.  The Compensation Committee determines the number of shares of Non-Vested Stock granted to eligible executives.  See Exhibit 20 for vesting eligibility of granted shares.  Interestingly, the Company achieved its primary performance objectives set for fiscal 2021 (based on Pre-Bonus Net Income) and thus 100% of the shares granted to executive officers and others on January 31, 2021, were eligible for vesting.

Although we believe that a return-based incentive program is better long-term for investors, we find this approach decently acceptable as it allows the senior operating team to focus strictly on operating performance by increasing store productivity, product margins and thereby absolute net income.  Per share ROE or ROIC can then be managed through effective capital management.  We believe, that given the size of insider ownership (40% of total shares), senior management has effectively executed capital management through the use of little to no debt and large dividends and share repurchases.  Key named management executive bios can be found in Exhibit 21.

Below (see Exhibit 22)is a historical compensation analysis for BKE’s senior team.  Cumulative compensation for management has been significant, particularly for Mr. Nelson who received ~$75 million in compensation and most likely $120 million in shareholder distributions ($195 million total), as he has owned >5% of the stock since 2009.  

Negatives

Cyclical Nature of Fashion

The Company’s comparable store net sales results have fluctuated in the past and are expected to continue to fluctuate in the future. A variety of factors affect comparable store sales results, including changes in fashion trends, changes in the Company’s merchandise mix, calendar shifts of holiday periods, actions by competitors, weather conditions, and general economic conditions

With an understanding of the cyclical nature of fashion, BKE has always operated its business with a focus on maximizing long-term profitability for shareholders.  Despite during fiscal years 2015, 2016, and 2017, comparable store sales declined 4.4%, 13.5%, and 7.2%, BKE was able to manage its cash conversion and purchasing cycles to maintain both merchandise margin expansion.  This period is considered an industry specific recession for U.S. retailers, as many U.S. retailers face similar margin pressures.  Interestingly, BKE weathered this period far better than peers.  This includes during COVID, where BKE not only saw productivity but margin expansion versus peers (see Exhibit 23 and Exhibit 24).

Aging Management (no clear transition leadership)

President and CEO, Dennis Nelson, and Chairman, Daniel Hirschfeld both to be in the twilight of their careers, despite exemplary careers.  Nelson is 72 and Hirschfeld is 80, and both collectively own over 37% of the outstanding shares.  It is worth noting, but not a surprise, that Hirschfeld has sold over 25% of his shares since 2005, going from >50% to 33% controlled ownership.  Although the board promotes talent from within, there is no clear management succession plan and despite a top-class compensation program, management rewards its employees with cash not stock.  In fact, no executive, outside Nelson and Hirschfeld, owns > 0.5% (50 bps) of the Company’s shares (see Exhibit 2).  

There has always been an unspoken rule for managing compensation (both on Wall Street and in VC): (i) pay employees more in stock bonuses in high-growing revenue businesses to conserve and selectively target cash growth outlays; and (ii) pay employees more in cash bonuses in little-to-no-growth-profitable businesses to preserve cash flow, and dissuade outsiders from ruining a cash cow.  We believe that carefully determining who gets shares can always keep a good cash machine and/or growth going.  Goldman Sachs is probably one of the few companies in the world that pays its best employees in stock to continue the owner-manager mindset, no wonder it has maintained itself as the best financial firm in the world consistently since 1920, with very little argument otherwise.  

BKE’s annual CEO letters pride itself on always operating the business with “a focus on maximizing long-term profitability for our loyal shareholders,” however, until a clear succession plan is laid out we fear that BKE’s shareholder-friendly days might come to an end in the next 10 years. At this point in the Company’s life cycle, it is critical that the board ensures knowledge transfer to younger executives.  Unfortunately, without proper share ownership incentives, cultural disruption might be imminent, and the board might be forced to recruit its next CEO/COO talent externally.  One of the Company’s strongest investment themes has been its rare mix of owner/managers who understand shareholder value. How unfortunate would it be, then, if this is not the most important item for shareholders over the next five years?

Peak Margins

The Company has consistently grown margins throughout its history.  Despite the volatility in comparable store sales over the last 20 years, the Company has built stores at a 6% CAGR while increasing productivity by 2% CAGR.  As a result, margins have been steadily increasing, despite three global recessions.  As of July 31, 2022, LTM EBIT margins came in at 25.2%.  Trailing 5-year, 10-year, and 20-year EBIT margins are 17.5%, 19.4%, and 18.1%.  Margins and store productivity are at all-time highs since 1992 (see Exhibit 13 and Exhibit 14).  BKE may have reached growth maturity in margins or at the very least is at an operating performance plateau.  The market, on the other hand, expects growth to slow as the Company expands into new markets and as peaking margins and average unit retail price (AUR) make comp and margin growth tougher to achieve.   As earnings growth slows, the market appears to see less room for stock appreciation than at faster-growing specialty retailers (e.g., Lululemon, TJ Maxx, Ross Stores, and Dick’s Sporting).  

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Earnings Outlook

As mentioned above, the Company has been able to consistently improve store productivity and margins, while holding store count growth steadily over the last six years.  Operating margins currently stand at 25.2%.  We believe most of the improvement has come in the form of the following efficiencies (see Exhibit 25): (i) increasing product margins by ~1,340 bps from 46.3% to 59.8%, due to increased sales in private label items, online items and increasing overall unit prices by $13 per item; (ii) lowering occupancy expense by ~450 bps from 13.6% to 9.1% of revenue, due to effective real estate/leasing management by Brett Milkie and his team (this impact is material GAAP occupancy expense increased due to adoption of new lease accounting Topic 842); and (iii) keeping overhead costs of as a percentage of sales at 4%, most likely due to improved centralized purchasing, distribution and call center functionalities.  The majority of BKE's expenses are variable and move in tandem with sales due to a payout structure largely focused on incentive comp and commission-based selling.  This means that the Company may not benefit from scale economies as other companies with larger amounts of fixed costs.  The company pays its salespeople a base wage plus commission and managers earn a salary coupled with a percent of income generated by their stores along with monthly and annual bonuses based on sales goals (see Compensation section above).  We believe that annual selling expenses will remain 18%-20% of sales regardless of top-line changes and we forecast G&A expenses to be 3.9% of sales.

We believe that management should be able to sustain EBIT margins of 18%-20% over the next few years while growing top line modestly 6%-8% per year.  Given BKE’s capital management prowess, we believe that ROAs should continue in the mid-20s to 30s (ROEs should be much higher).  This should translate into similar increases in shareholder value, either in the form of dividends and/or stock price appreciation.  The Company currently has nearly a 100% dividend payout ratio.  

Valuation

In order to appreciate BKE’s valuation, an understanding of the retailer apparel sub-sector profitability and valuation dynamics are needed.  We define the retail apparel sector in Exhibit 26.  We believe that Buckle’s peer group are Big Box Retailers (see Exhibit 27 and Exhibit 28), although BKE is one of smaller overall players within the group.  Although BKE should not be part these subsectors, Luxury and Footwear should be used as ceiling and floor groups when comparing retail apparel.  

Profiling 484 publicly traded global retailers and vendors, demonstrate that luxury brand retailers (e.g., Louis Vuitton, Hermès, Prada, Burberry, Christian Dior, Kering, Hugo Boss, Ferragamo, etc.) not only command the top margins in the industry (see Exhibit 29 and Exhibit 30), but also have done so for the last 30 years (see Exhibit 31 through Exhibit 36).  Not surprisingly, Luxury Retailers command the highest multiples as these franchises command quality and emerging market penetration (see Exhibit 39 through Exhibit 41).  The opposite is true for Footwear Retailers, as a whole.  However, BKE’s margins perform in line with the top Luxury Retailers (i.e., Louis Vuitton and Christian Dior), having outperformed many of the top luxury brands in the world (see Exhibit 29).  In fact, within its category, it is the top performing company, just ahead of lululemon.  

The majority of companies in the Big-Box Retailer group are retailers with recognizable private-label branding.  The average productivity for these retailers is $3-$4 million per store (see Exhibit 23).  Not surprisingly, TJ Max, Ross Stores, Dick’s Sporting, and Lululemon all have store productivity greater than $10 million per store.  It is no wonder that BKE goes unnoticed by investors due to its underwhelming productivity (~$1 million below other Big-Box retailers) and no real growth prospects (management does not allay these concerns either).  

It has been our experience that companies that command large enviable valuations are not just based on historical and “expected” performance, but mainly on expected growth.  The more consistent a company’s performance behaves, with no growth prospects, the closer it can be valued using perpetuity growth valuations, since it behaves more like an annuity.  Investors have special portfolio uses for annuities and perpetuities but have little tolerance to use significant investments in companies that do not grow.  

We believe that the market may be pricing BKE with anemic store growth, 5 store openings per year.  This would suggest 25 new stores over the next five years, which is in line with BKE’s latest growth performance.  In addition, the market may be weary that BKE is at “peak” operating margins at 22.6%, when they have been as low as 14% four years ago and as high as 20% ten years earlier (see Exhibit 38).  As a result, the market may be factoring operating margin compression to more historical average levels of 15% to 16%.  Our analysis on retail store productivity has shown decreasing productivity for many retailers, post the COVID-19 pandemic.  In fact, many retailers have been closing key store venues to allay slowing store productivity trends (i.e., Gap, Abercrombie, Aeropostale, Claire’s, Chico’s, Ann Taylor, LOFT, and American Eagle).  If we assume that mature, profitable retail stocks should trade at historical levels of 11x or greater (see Exhibit 40), then the market is pricing BKE’s valuation at around $36 per share.  

Despite our agreement with the market that BKE should hit maturity over the next 5 years, given senior management’s aging grip hold on the Company’s outlook, we are more realistic on fair valuation of the stock.  Therefore, we assumed that the Company will have hit maturity and saturated their target market by 2027.  However, we do believe that management should be able to improve store productivity at its historical 20-year average of 4% per year to reach ~$3.5 million of net sales per store by 2027.  Next, we assumed that it would cost the Company approximately $30 million to build 25 new stores and $46 million to renovate and maintain its existing 442 stores over the same five-year period.  We assume that the Company’s internal cash flow from existing stores and new stores should help finance all the new store build and should not require additional debt or equity issuances.  

Our analysis comes out to an intrinsic value of approximately $50 per share, which would suggest a 51% premium to current stock levels.  We, therefore, believe that the securities may be temporarily slightly mispriced.  

We believe that the current economic uncertainty in the general market may create opportunities to purchase the stock at levels significantly below current levels.  However, current open option interest is heavily weighted to $50.50 strike calls, which may suggest that the market is more bullish than bearish on the stock.  

Using sensitivity analysis on some of our key assumptions shows that we have a decent amount of room for upside in the security.  We believe max fair value may be closer to 26% margins and 14x P/E (~10x EBIT multiple) or ~$70/share (Exhibit 44 to Exhibit 47).  This would imply over a 100% upside from current levels.  Nevertheless, we are also mindful of the downside and would not be surprised if the market prices the security at 12% operating margins and an 5x EBIT multiples.  These assumptions would suggest a value of below $30 per share for BKE or a >25% downside from current levels (Exhibit 44 to Exhibit 47).  Assuming no material changes in the fundamentals of the Company, these latter assumptions may prove to be overly penalizing to a management and franchise with an excellent history of operating performance execution capabilities.   Therefore, we believe a reasonable floor exists in the stock of no lower than $25 per share, at which point we would be heavy buyers of BKE, making it a significant position in our portfolio. 

Recommendation and Rationale

Catalysts

Risks

There is a risk related to BKE’s earnings outlook and stock price relative to market expectations.  Assuming no material changes in the operating fundamentals of the business, we view the potential for the market outlook to be negatively over-focused on SSS and EPS growth.  Therefore, if SSS comps or SSF come in lighter, we would expect a short-term downward correction in the stock price.  This could be amplified if there is further pressure in the macroeconomic environment on discretionary consumer spending.  Currently, we view the market is over-looking the fact that Company can generate strong returns on cash per share and effectively return cash to investors, especially if it turns out that BKE’s growth prospects remain slower.  Finally, uncertainty in aging senior management succession places a significant risk in the Company’s ability to maintain its shareholder friendly strategy over the next 10 years . 

Ratings (1 to 10: 1 = exceptional; 10 = nonsensical, absurdity)

• Value (intrinsic value > MV?): 3.50

• Downside Protection (low risk of perm. loss?): 3.50

• Management (capable and properly incentivized): 1.50

• Financial Strength (solid balance sheet?): 1.00

• Moat (able to sustain high ROIC?): 2.00

• Earnings Momentum (fundamentals improving?): 3.00

• Macro (poised to benefit from econ./secular trend?): 1.50

Margin of Safety (median of collection of above metrics): 2.00

Catalyst